Allocating the Purchase Price of Business Assets Acquired
A business contract to purchase a business is a legally binding agreement between the purchaser and vendor. Although the contract can be verbal, a written contract is recommended as it provides proof of what was agreed upon, prevents misunderstanding, prevents parties changing the terms later, and makes the parties come to a definite agreement. Business contracts should always be drafted by solicitors.
When buying a business the purchaser may be acquiring the following different asset components:
• Goodwill,
• Trading stock,
• Freehold property, and
• Depreciating assets and intellectual property.
If the total purchase price is allocated in the sale contract between the different asset components acquired, then the purchaser takes those values for tax purposes. So for example, a $1,000,000 sales contract could allocate $500,000 to goodwill, $250,000 to depreciating assets and $250,000 to stock.
From the purchaser’s point of view they would prefer larger values for the depreciable assets and less for the goodwill. This is because the depreciable assets will provide the purchaser with tax deductions in future years for the depreciation expenses. In contrast, there is no write-off for goodwill as it’s a capital asset. Where the contract of sale does not allocate the total purchase price amongst the assets acquired, and then the purchaser can make that allocation themselves (subject to the values allocated to the various assets being commercially realistic).
